The economy is improving, but no reference to Trump-related uncertainty

Fed is waiting for more information about Trump’s fiscal policy stimulus

The policy rate is likely to increase more gradually than markets currently expect

Interest rates on hold and no hints about the timing of upcoming rate increases

At its meeting on January 31-February 1, the Federal Open Market Committee (FOMC) decided, as expected, to leave rates unchanged. The decision was unanimous. The statement published after the meeting said that job gains have remained solid with the unemployment rate staying near its recent low. Household spending has continued to rise moderately, while business fixed investment has remained soft. Measures of consumer and business sentiment have improved lately. Moreover, market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations barely changed, on balance. Finally, the FOMC expects that “with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labour market conditions will strengthen somewhat further and inflation will rise to 2 percent over the medium term”. At its previous meeting in December of last year, Fed officials revised their individual interest rate forecasts upward. Currently, the median official forecasts three rate increases of 0.25 percentage points each in 2017, 2018 and 2019, which is in line with current market expectations.

Fed is waiting for more information about Trump’s fiscal policy stimulus

In our view, the FOMC will remain in a 'wait-and-see' mode until: 1) the uncertainty surrounding the magnitude, composition and timing of Trump’s anticipated fiscal stimulus fades; and, 2) the economic impact from the decided policy becomes more clear. At present, neither of those criteria are fulfilled. At its meeting ending on February 1, the FOMC saw “near-term risks to the economic outlook as roughly balanced”. We expect that the Fed will keep its prevailing strategy and avoid tightening policy in ways that could jeopardise growth.

The policy rate is likely to increase more gradually than markets currently expect

Our forecast is that GDP growth will remain moderate until the second half of 2017, when Trump’s fiscal policy stimulus would likely trigger a short-lived economic expansion followed by an economic slowdown. Prevailing economic conditions make a sustainable increase in growth unlikely, in our view. Low productivity growth and high resource utilisation imply that high growth over a longer period would lead to a significant drop in the unemployment rate and economic overheating, which effectively would slow growth. We believe that the Fed will increase rates by 0.25 percentage points in September of this year and then deliver another increase of the same size in March 2018. That will likely be the last rate increase in this business cycle, as we expect the economy to slow in the second half of 2018.